File C5-97
June 2013
www.extension.iastate.edu/agdm
Financial Ratios
F
inancial ratios are used to provide a quick
assessment of potential financial difficulties
and dangers. Ratios provide you with a
unique perspective and insight into the business. If a
financial ratio identifies a potential problem, further
investigation is needed to determine if a problem
exists and how to correct it. Although there are often
specific benchmarks attached to ratios to indicate
when there is cause for concern, ratios should also
be thought of as a continuum from weak to strong
with the stronger the ratio the better. Ratios can
identify problems by the size of the ratio but also by
the direction of the ratio over time.
Liquidity Ratios
Current Ratio – A firm’s total current assets are
divided by its total current liabilities. It shows
the ability of a firm to meets its current liabilities
with current assets.
Quick Ratio – A firm’s cash or near cash current assets divided by its total current liabilities.
It shows the ability of a firm to quickly meet its
current liabilities.
Net Working Capital Ratio – A firm’s current
assets less its current liabilities divided by its total
assets. It shows the amount of additional funds
available for financing operations in relationship
to the size of the business.
Asset Management Ratios
Days Sales Outstanding – A firm’s accounts
receivables divided by its average daily sales. It
shows the average length of time a firm must wait
after making a sale before it receives payment.
Fixed Asset Turnover Ratio – A firm’s total
sales divided by its net fixed assets. It is a measure of how efficiently a firm uses its plant and
equipment.
Inventory Turnover Ratio – A firm’s total sales
divided by its inventories. It shows the number of
times a firm’s inventories are sold-out and need to
be restocked during the year.
Total Assets Turnover Ratio – A firm’s total
sales divided by its total assets. It is a measure of
how efficiently a firm uses its assets.
Debt Management Ratios
Debt to Asset Ratio – A firm’s total debt divided
by its total assets. It is a measure of how much of
the firm is debt financed.
Debt Coverage Ratio or Debt Service Coverage
Ratio (DSCR) – A firm’s cash available for
debt service divided by the cash needed for debt
service. It is a measure of a firm’s ability to
service its debt obligations.
Times Interest Earned Ratio (TIE) – A firm’s
earnings before interest and taxes (EBIT) divided
by its interest charges. It shows a firm’s ability
to meet its interest payments. It is also called the
interest coverage ratio.
Earnings Before Interest, Taxes, Depreciation,
and Amortization (EBITDA) Coverage Ratio
– A firm’s cash flow available to meet fixed
financial charges divided by the firm’s fixed
financial charges. It shows the ability of a firm to
meet its fixed financial charges.
Profitability Ratios
Profit Margin on Sales – A firm’s net income
divided by its sales. It shows the ability of sales
to generate net income.
Basic Earning Power (BEP) – A firm’s earnings
before interest and taxes (EBIT) divided by its total assets. It shows the earning ability of a firm’s
assets before the influence of taxes and interest
(leverage).
Don Hofstrand
retired extension agriculture specialist
agdm@iastate.edu
Page 2
Return on Total Assets (ROA) – A firm’s net
income divided by its total assets (both debt and
equity supported assets). It shows the ability of
the firm’s assets to generate net income. Interest
expense is added back to net income because interest is a form of return on debt-financed assets.
File C5-97
Market Value Ratios
Price/Earnings Ratio (P/E) – The price per
share of a firm is divided by its earnings per
share. It shows the price investors are willing to
pay per dollar of the firm’s earnings.
Return on Equity (ROE) – A firm’s net income
divided by its equity. It shows the ability of the
firm’s equity to generate profits.
Price/Cash Flow Ratio – The price per share of
a firm divided by its cash flow per share. It shows
the price investors are willing to pay per dollar of
net cash flow of the firm.
Return on Investment (ROI) – A firm’s net income divided by the owner’s original investment
in the firm.
Market-to-book value (M/B) – The market
value of a firm is divided by its book value.
Earnings per Share – A firm’s net income per
share of stock.
. . . and justice for all
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Issued in furtherance of Cooperative Extension work, Acts of May 8 and November 30, 1914,
in cooperation with the U.S. Department of Agriculture. Cathann A. Kress, director, Cooperative
Extension Service, Iowa State University of Science and Technology, Ames, Iowa.